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Better Buy: Intel Corporation or Ambarella Inc.?

By Leo Sun - Feb 22, 2016 at 9:03PM

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Which beaten-down chipmaker is a better investment for 2016?

It's been a tough year so far for chipmakers Intel (INTC -2.86%) and Ambarella (AMBA -3.31%). Intel stock has declined 17% on concerns about its PC and data center businesses, while Ambarella stock has slumped 24% on slowing demand for action cameras.

Although the two chipmakers produce different chips for different markets, they still have overlapping interests in drones and other key markets. Let's compare both companies' strengths and weaknesses to see which looks like a better buy today.

Intel's strengths and weaknesses
Intel is the largest maker of x86 chips for PCs and data centers in the world. However, the company has also been expanding into mobile chips, Internet of Things (IoT) modules, and non-volatile memory.

Source: Intel.

Intel's Client Computing group, which consists of its PC and mobile businesses, is the company's biggest and weakest unit. In 2015, the unit's revenue fell 8% to $32.2 billion, and operating income declined 21% to $8.2 billion. Sales of PC chips were weighed down by annual declines in worldwide PC shipments, while sales of its heavily subsidized mobile chips struggled to gain market share against dominant rivals Qualcomm (QCOM -3.30%) and MediaTek. That pain will likely continue in 2016 -- IDC doesn't see PC growth stabilizing until 2017, while low-cost players like MediaTek will keep driving down mobile chip prices.

Intel's Data Center group, which controls about 99% of the global server market, is faring better. Last year, revenue rose 11% to $16 billion, and operating income climbed 6% to $7.8 billion. Unfortunately, the unit's sales growth came in below Intel's prior forecast for 15% growth through 2018. Intel blamed that miss on macro weakness weighing on enterprise growth and softer-than-expected demand at the beginning of the year. New server rivals like Qualcomm could also start chipping away at Intel's dominance of the data center market.

Intel's IoT group revenue rose just 7% to $2.3 billion, while operating income slipped 12% to $515 million. This indicates that IoT chip margins are falling as mobile chipmakers like Qualcomm and MediaTek enter the market. Non-volatile memory revenue grew 21% to over $2.5 billion, but Intel didn't disclose the unit's profits. Looking ahead, analysts expect Intel's revenue and earnings to respectively rise 6.6% and 3.9% in 2016. That compares favorably to its 0.9% sales decline and 0.9% earnings growth in 2015.

Ambarella's strengths and weaknesses
Ambarella produces image processing systems-on-a-chip (SoCs) for a wide range of action camera, drone, and connected camera makers worldwide. However, its biggest customer is GoPro (GPRO 0.54%), which could generate up to a fourth of its sales this year, according to Pacific Crest estimates.

Source: Ambarella.

Ambarella's relationship with GoPro was a blessing when its camera sales were soaring, but it has now become a curse after GoPro's growth hit a brick wall. After a dismal holiday quarter, analysts now expect GoPro's sales to fall 15% this year, down from 41% growth in 2014 and 16% growth in 2015. Last quarter, Ambarella warned that its fourth-quarter sales (which will be reported on March 3) will only rise 0.5% to 4.3% annually, compared with 62% growth a year earlier.

Ambarella believes that it can diversify its top line away from the action camera market with drones, which account for about 10% of its sales. However, Qualcomm has been expanding into this market with its own drone reference designs, which Morgan Stanley believes could have a price advantage against Ambarella's SoCs if cellular connections are factored in. Recent reports also indicate that Qualcomm has been pursuing design wins from top Ambarella clients DJI Innovations and GoPro. If Ambarella loses those two customers, its top line and reputation would take a big hit. Qualcomm is also expanding heavily into connected cameras and cars -- two of Ambarella's pillars of growth.

Last quarter, Amabrella's revenue rose 42% annually to $93.2 million and net income soared 61% to $29.5 million. Analysts currently expect Ambarella to have finished fiscal 2016 (which ended on Jan. 31) with 43.8% sales and 56% earnings growth. However, sales growth is expected to fall to just 11.1% in 2017 because of its struggles in wearable cameras and rising competition from mobile chipmakers. Full-year earnings are expected to decline 5.8%.

Valuations and verdict
Intel currently trades at 12 times earnings, which is lower than the industry average of 17 for broadline semiconductor companies. Ambarella's P/E of 16 is tied with the average ratio for semiconductor equipment companies. Intel also pays a forward annual dividend yield of 3.6%, while Ambarella doesn't pay one at all.

Intel's business model, while under pressure, isn't tied to a single large customer like Ambarella's. Intel also doesn't face the threat of a bigger company rendering its chips obsolete -- something that Qualcomm could do to Ambarella in the near future. Based on those numbers and facts, Intel looks like a better investment than Ambarella at current prices.

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Stocks Mentioned

Intel Corporation Stock Quote
Intel Corporation
$36.34 (-2.86%) $-1.07
Ambarella, Inc. Stock Quote
Ambarella, Inc.
$63.29 (-3.31%) $-2.17
QUALCOMM Incorporated Stock Quote
QUALCOMM Incorporated
$123.53 (-3.30%) $-4.21
GoPro, Inc. Stock Quote
GoPro, Inc.
$5.56 (0.54%) $0.03

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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